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Interest/Maturity Gap and Sensitivity

Interest/Maturity Gap and Sensitivity. Interest/Maturity Gap. G & K Chp. 5 Why Gap? Manage on- or off-balance sheet Off-Balance Sheet (Futures, Options, later….) Economic Environment Maturity Gap Duration Gap. Why Gap?.

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Interest/Maturity Gap and Sensitivity

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  1. Interest/Maturity GapandSensitivity

  2. Interest/Maturity Gap • G & K Chp. 5 • Why Gap? Manage on- or off-balance sheet • Off-Balance Sheet (Futures, Options, later….) • Economic Environment • Maturity Gap • Duration Gap

  3. Why Gap? • Maturity Pattern and Interest Rate Sensitivity of Assets and Liabilities differ. • Fixed Rate Investment funded by Floating Rates can create Spread Squeezes. • Want to create stable Spread, and force maximum funds through…… • Changes in interest rates compound spread management by imparting value management in addition.

  4. Business Cycle and Interest Rates • Trough: Low economic activity; low demand for funds, high demand for safe, liquid investments  Low relative rates, + - curve • Growth to Peak: Increasing economic activity; high demand for funds, low demand for interest-rate investments  Higher relative rates, + - to – flattening curve • SlowdownTrough; Slowing economic activity, early high demand for funds gives rise to drop off  High rates drop, with inverted-curve returning to positive slope

  5. Maturity Gap • Repricing of Book Values of Assets vs. Liabilities in common time periods • Pg. 5 of any output • Rate Sensitive Assets (RSAs) and Rate Sensitive Liabilities (RSLs) • 3, 6, 9 mo., 1 yr., 1-3 yrs., Over 3 yrs. • Idea is: (Gap = RSA – RSL) NII = Gap *  R

  6. Maturity Gap • Rates Go Up • Positive Gap  Increase NII • Negative Gap  Decrease NII • Rates Go Down • Positive Gap  Decrease NII • Negative Gap  Increase NII • Problems: • Ignores Market Value Changes • Ignores variation in intra-bucket value changes • Concentrates on single-period CF, not MV

  7. Maturity Gap • Y1Q4: • 3 month Assets: 3596.96 • 3 month Liabilities: 2617.51 • RSA – RSL = 3 month Gap = 979.45 • 3 month Interest Rates go up .25% • NII should jump (0.0025*979.45) $2.45 mill

  8. Duration Gap • Duration Weighted Assets and Liabilities • Managing the Change in Equity (Value) from a change in interest rates and their effect on Assets and Liabilities • Remember: Price = - D * r / (1 + YTM) * Price • Applied to Assets and Liabilities: A = - DA * R / (1 + R) * A L = - DL * R / (1 + R) * L

  9. Duration Gap • Then: E = A - L • E = -[ DA - DL (L/A)] * [R/(1+R)] * A Change in Equity is negative of difference in durations multiplied by interest rate change multiplied by asset base

  10. Duration Gap • Rates Go Up • Positive Duration Gap  Decrease Value • Negative Duration Gap  Increase Value • Rates Go Down • Positive Duration Gap  Increase Value • Negative Duration Gap  Decrease Value

  11. Duration Gap • From 1.4 Output: • Assets: Duration = 0.427 , Value = $4.897 bill • Liabs: Duration = 1.103, Value = $4.609 bill • Notice……Negatively Gapped! • Assume R=7% 7.05% E = -[ DA - DL (L/A)] * (R/(1+R) * A = -[.427 – 1.103 (4.609/4.897)]*(+.0005/1.07)*4.897 = +0.00139846 = +$ 1.39846 million

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